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Tax Credits and the Affordability of Individual Health Insurance

Issue Brief No. 53July 2002
Jack Hadley, James D. Reschovsky

s federal policy makers explore using tax credits to help
uninsured Americans buy individual health insurance, a key question is whether
the credits are large enough to make insurance affordable for those who are
older or in less-than-perfect health. A Center for Studying Health System Change
(HSC) analysis of two leading proposalsone by President Bush and the
other by a bipartisan group of senatorsindicates tax credits would make individual
coverage affordable for many people but are unlikely to offer much help to those
who are older or in imperfect health. For example, nine out of 10 19- to 29-year-olds
in excellent health would receive credits covering at least half of the estimated
cost of an individual policy, compared with only one in 100 people age 55-64
in poor health.

Understanding the Individual Insurance Market

n 2000-01, slightly more than 30 million people under
the age of 65 were uninsured and did not have access to employer-sponsored insurance.1
Recent proposals seek to encourage people without access to employer-sponsored
insurance and who are ineligible for public insurance programs to buy individual,
or non-group, insurance by offering income-related tax credits to reduce the
cost of insurance (see box). Currently, only 10.3 million
Americans, or 5 percent of the nonelderly insured population, have individual
insurance.

A key policy question is whether
proposed tax credits are large enough
to make individual insurance affordable
for older people or people in less-
than-perfect health, many of whom
are either priced out or shut out of the
current individual insurance market.
The answer depends on how much it
costs to buy individual insurance for
those eligible for tax credits. Even large
tax credits may be insufficient to make
insurance affordable for those facing
the highest premiums because of their
age or health.2

Determining the cost of individual insurance is complicated because of the
prevalence of medical underwriting in the individual market.3
Some argue that people with preexisting medical conditions may be unable to
obtain any offers of insurance or, if they do, the price is unaffordable or
the coverage excludes care for their conditions.4
Others maintain that actual experience with individual insurance indicates relatively
little medical underwriting, that costs are not very sensitive to differences
in peoples health conditions and that decisions to purchase coverage are not
strongly related to health.5

HSC analyzed the cost of individual insurance using premiums reported by people
nationwide in the Community Tracking Study (CTS) Household Survey in 1996-97
and 1998-99 (see Data Source and Methods). Estimated
individual insurance premiums for a single person increase with both advancing
age and declining health. For example:

An average individual insurance policy
costs a single person age 19-29 who is
in excellent health an estimated $121 a
month, or $1,452 a year. If that same person
is in poor health, the policy will cost
$180 a month, or $2,160 a year.
8

A single person age 55-64 in excellent
health would pay about $177 a month,
or $2,124 a year. A person 55-64 in poor
health would pay $273, or $3,276 a year, a
54 percent difference.

In 1998-99, 6 million uninsured
nonelderly adults reported their health as
either fair or poor. Another 7.5 million uninsured
people in good or excellent health
reported having at least one health condition
that could lead to higher prices or coverage
exclusions in the individual market.

How Far Can Tax Credits Reach?

o analyze the potential impact of proposed
tax credits on the individual market, HSC
identified people likely to qualify for a credit
based on their current insurance coverage
and income.9
An analysis of CTS data suggests
that an estimated 28.6 million people without
access to employer-sponsored or public insurance
would be eligible to receive a credit under
the REACH proposal. Most (88%) of these
people, or 25.2 million, also would receive a
credit under the Bush plan. About 80 percent
of those eligible for a credit under either plan
are uninsured (the remaining 20 percent
already have individual insurance coverage).

Looking only at the uninsured, the
REACH bill would provide a larger average
credit per family: $1,535, compared with
$1,155 for the Bush plan. Consequently, the
REACH proposal would provide a larger
average subsidy of the estimated premium
for individual insurance: 54 percent, compared
with 43 percent for the Bush plan.

Even if the credit provides a substantial
reduction in what consumers pay for insurance,
the after-credit premium still needs to
be affordable to induce people to purchase
coverage. While the relationship among
income, price, subsidy percentage and the
decision to purchase insurance is complex,
a useful yardstick for measuring affordability
is the premium as a percentage of family
income. Based on CTS data for people who
currently own individual insurance policies,
about half spend 8 percent or less of their
income for coverage, and about three-quarters
pay less than 16 percent of their income.

To gauge whether people would be more
or less likely to buy coverage with a tax credit,
HSC simulated the proportions of people
who would be:

more likely to buy coverage (those
who would pay less than 8 percent of
family income);

somewhat more likely to buy coverage
(those who would pay between 8 percent
and 16 percent); and

least likely to buy coverage (those who
would pay more than 16 percent of
family income).

Without a tax credit, uninsured people would spend an average of 25 percent
of their income to buy individual coverage. The Bush proposal would drop that
average to 16 percent; the REACH plan would lower it further to 14 percent.

Under both proposals, substantial numbers of people would receive credits
covering 50 percent or more of the cost of individual insurance and, as a consequence,
would face post-credit insurance costs of less than 8 percent of income. The
REACH proposal is more generous. It provides larger subsidiesmore than
50 percent of the cost of insuranceto more people and shifts more people
into the affordable range, or a post-credit premium of less than 8 percent of
income. Under REACH, the tax credit would cover at least half of the cost of
individual insurance for 58 percent of uninsured people presumed eligible for
a credit, compared with 31 percent of uninsured people under the Bush plan (see
Figure 1).

Without tax credits, only 18 percent of
uninsured eligibles are estimated to face
insurance costs of less than 8 percent of
family income, and even with this arguably
affordable cost, these people remain uninsured.
Both tax credit proposals increase
the proportion of uninsured people who
would fall into the affordable range: 53
percent under REACH and 44 percent
under the Bush proposal, although 22 percent
to 26 percent would still face post-credit
premiums amounting to more than
16 percent of their incomes plan (see Figure 2).

Less Help for Those Most in Need

oth proposals would provide significant help to a substantial
number of people. But both are also limited in how much they can help those
who are older, are in poorer health or have very low incomes. Even under the
more generous REACH proposal, only 22 percent of the poorest people would face
post-credit premiums in the affordable range, compared with more than two-thirds
of those with family incomes above poverty. More than four times as many of
the poorest people would still face premiums exceeding 16 percent of their incomes46
percent of the poorest, compared with 10 to 12 percent of the nonpoor (see
Table 1).

Post-credit premiums also become
much less affordable as peoples health
worsens or they grow older. Almost two-thirds
of people in poor health would still
have to pay more than 16 percent of their
incomes, compared with only 12 percent
of people in excellent health. Similarly, 43
percent of people 55-64 would still find
premiums unaffordable, compared with 15
percent of 19- to 29-year-olds.

The combined effects of age and health
create wide variations in the degree of
assistance tax credits would provide
toward purchasing individual coverage.
For example:

Ninety-one percent of people 19-29 in
excellent health would receive credits
covering at least half of the cost of an
individual insurance policy, and three-fourths
would spend less than 8 percent
of their income to pay their share.

One-third of people 55-64 who are in
excellent health would receive a credit
covering at least half of their cost of
insurance, but only 10 percent of those
in fair health would receive similar
assistance.

Only 1 percent of people 55-64 in poor
health would receive credits covering
half of the cost of individual insurance.

Half of older people in fair health and
69 percent of those in poor health still
would need to spend more than 16 percent
of their income on insurance after
the credits.

Table 1
REACH Proposal: Distribution of People by Post-Credit Affordability of Individual
Insurance, by Poverty Status, Health Status and Age*

Premium as a Percent of Family Income

Subsidy More Than 50%

Less Than 8%

8-16%

More Than 16%

Poverty Status

Less Than 100% FPL

22%

32%

46%

55%

100-200% FPL

66

24

10

64

More Than 200% FPL

68

20

12

54

Health Status

Excellent

66

22

12

71

Very Good or Good

54

26

20

58

Fair

41

28

31

48

Poor

18

22

60

24

Age

19-29

64

21

15

81

30-44

54

27

19

56

45-54

39

27

34

32

55-64

30

27

43

13

Age and Health Status

Age 19-29
in Excellent Health

76

15

9

91

Age 55-64
in Excellent Health

29

51

20

33

Age 55-64
in Fair Health

24

26

50

10

Age 55-64
in Poor Health

13

18

69

1

* When the Bush proposal is evaluated, similar
distributions result. These are available in web-exclusive tables at www.hschange.org.

Policy Implications

his analysis suggests that tax credits based
only on income and family size will fail to
help many in greatest need of coverage.
Structuring a tax credit to vary with the
ages of the recipients, as well as with
income and family size, would help uninsured
people in poorer health to purchase
health insurance, because health tends to
decline with age and insurance premiums are
known to vary with age. Basing the size of the
credit on income relative to the poverty line
and providing larger credits than under the
current proposals for those below poverty
could improve affordability for the very poor.

Adjusting tax credits for variations in
health is a much more complex and challenging
task. Roughly 6 million uninsured
people are currently in fair or poor health,
and another 7.5 million are in good health
but have one or more potentially chronic
health conditions. Many of these people might
not be able to buy an individual insurance
policy at any price, so an alternative approach
that complements a tax credit may be needed.

One option is to build on the experiences
of state high-risk pools, using a decentralized
network of administrative offices to screen
applicants health conditions.
10
The tax credit
amount might be increased for people who
qualify for high-risk pools, since premiums
charged by the pools can be high.
11
If variations
in the availability and structure of high-risk
pools across states are viewed as
inequitable, then a national pool or a joint
federal-state approach could be evaluated.

Policy makers also might consider
restructuring the individual insurance market. Concerns about potential adverse effects
on market structure of regulatory requirements
such as guaranteed issue, guaranteed
renewal and medical-underwriting restrictions
may be alleviated if tax credits expand
the size of the individual insurance market
by attracting large numbers of relatively
healthy people.

Another option is reinsurance of individual
policies or after-the-fact compensation of
insurers for people who have very large medical
expenses. The cost of insurance for these
people would be spread over a potentially
much larger pool or be publicly funded,
depending on the specific mechanism used.
For example, New Yorks Healthy New York
program includes a reinsurance mechanism.12

Finally, many people with very low incomes may be eligible for existing public
insurance programssuggesting that more may need to be done to enroll them.
For others, such as adults without children or people in states with very low
income-eligibility thresholds for covering otherwise eligible adults, expanding
public insurance eligibility or allowing credits to be used to buy into existing
public insurance programs might be considered.

Making Health Insurance More Affordable: Two Tax-Credit
Proposals

President Bushs fiscal year 2003 budget includes an individual insurance tax credit
that would provide individuals with incomes under $15,000 with a $1,000 credit that
would decrease to zero at an income of $30,000. Families would receive $1,000 per
adult and $500 per child, up to a maximum of $3,000 for families with incomes up
to $25,000. Families with incomes of $60,000 or more would be ineligible.

The Relief, Equity, Access and Coverage for Health (REACH) Act of 2001 (S. 590)
proposes tax credits for people without access to employer-sponsored insurance of
up to $1,000 for individuals with adjusted gross incomes below $35,000 in 2002 and
$2,500 for families with incomes below $55,000.7
The tax credit amount would
decline as income increases. Individuals with incomes of $45,000 or more and families
with incomes of $65,000 or more would be ineligible.

Data Source and Methods

his Issue Brief presents findings
from HSCs Community Tracking
Study Household Survey conducted
in 1996-97 and 1998-99. That survey
is a nationally representative
telephone survey of the civilian,
noninstitutionalized population,
supplemented by in-person interviews
of households without
telephones to ensure proper representation.
Each round of the survey
contains information on about
60,000 people, and the response
rates ranged from 60 percent to
65 percent.

The cost of individual insurance
calculated for this Issue Brief
used premium data from almost
2,500 policies reported by survey
respondents. The analysis is based
on estimates of the cost of individual
insurance projected to the
entire population potentially eligible
to receive tax credits. The premium
estimates are adjusted for
the fact that people who actually
buy such policies may be in significantly
better health than those
who do not.6
Without making this
adjustment, actual premiums paid
by people currently in the individual
insurance market are not good
indicators of what it would cost
other people to buy individual
policies.

The analysis first examines whether health influences the likelihood that
a person will have nongroup insurance and then controls for that effect
in estimating the relationship between health and the cost of the policy
using a statistical method to adjust for selection bias. See Hadley, Jack,
and James Reschovsky, "Health and the Cost of Nongroup Insurance," unpublished
working paper, Center for Studying Health System Change, Washington, D.C.
(July 2002).

7.

REACH also includes provisions for tax credits
to subsidize premiums paid by low-income
people covered by employer-sponsored insurance
to discourage people from dropping unsubsidized
employer insurance in favor of subsidized
insurance. However, this analysis only
considers tax credits for individual insurance.

8.

The estimates for those in fair or poor health may still understate the
premiums they would face because the statistical adjustment was based only
on self-reported health status, rather than detailed information on specific
health conditions or physical limitations that insurance companies would
use in medical underwriting.

9.

We defined the eligible population as individuals,
families or parts of families that do not
have access to employer-sponsored coverage,
are not covered by public insurance and have
incomes below the maximum incomes specified
by the REACH proposal.